Cryptocurrency investments come with significant risks, including extreme volatility, regulatory uncertainty, and susceptibility to fraud. The decentralized nature of cryptocurrencies can lead to a lack of consumer protection, making investors vulnerable to scams and theft. Notably, Ponzi schemes have emerged as a prevalent form of fraud within the crypto space, promising high returns that are unsustainable and reliant on new investor capital. These schemes often disguise themselves as legitimate investment opportunities and make investors invest in a company that does not exist. The Ponzi scheme is one of the main reasons that people think Bitcoin is that it is a scam or fraud. This is because of several reasons, this can be due to limited knowledge of Ponzi schemes, or can be due to the lack of knowledge of Bitcoin and other cryptocurrencies.
In this guide, we will provide you with everything you need to know about Ponzi schemes, their workings, and how to avoid them.
Ponzi Scheme
A Ponzi scheme is a kind of investment fraudulent activity where a criminal recruits investors to invest in a cryptocurrency that does not exist in the real world. After solidifying the investment, the criminal steals the money of the investors. Then, to make it seem like these investors are receiving returns, the fraudsters recruit new investors and leverage their investments to pay off previous investors.
The name Ponzi scheme was introduced when an Italian businessman Charles Ponzi, pulled off a huge and infamous instance of the scheme in 1920. Charles Ponzi created a fake investment organization based around buying international postal vouchers in Europe and utilizing them for more expensive US postage stamps.
A Ponzi scheme will last only when no money is coming in. It will be based on the size of the required investment because a smaller investment means that a lot more people can participate and the scheme will last longer.
The sad truth is that people who invest in several Ponzi schemes will definitely lose their money. In the case of cryptocurrencies, people lose their money due to many reasons, including an unfortunate set of circumstances, human nature, and how markets work.
How Does a Ponzi Scheme Work?
The initial requirement of a Ponzi scheme is to get a criminal to convince individuals to invest in an enterprise that doesn’t exist. These criminals will typically promise high returns with less risk, two major things that are appealing to investors. They will create stories and provide fake paperwork to make it seem legitimate.
Once these criminals get the initial investments, they will create an illusion for investors that they are receiving returns. Once they succeed, they use the same trick with other individuals to make them invest money and then leverage that money to pay off the previous investors.
Let’s look at the steps involved in Ponzi schemes below:
- A fraudster will convince a group of people to invest in a cryptocurrency that does not exist.
- Investors who believe the fraudster give money to the fraudster, who keeps it for themselves.
- To pay off the investors, the fraudster seeks new individuals they can persuade to invest in the fraud.
- New investors entered into the scheme will give money to the fraudster, who then utilizes that money to pay off previous investors while keeping some for themselves.
- The process will repeat until no new investors can be identified, and the scheme collapses. Fraudsters will left with the money.
How to Identify Ponzi Schemes?
The U.S. Securities and Exchange Commission (SEC) has found numerous warning signs that an investment opportunity is actually a Ponzi scheme. Let’s look at those red flags to watch for:
Promises Huge Returns With Lesser Risk: This is one of the common indicators of Ponzi schemes and investment fraud. Investments that can generate high returns are usually impossible as well as risky, and no investment is completely risk-free.
Delivers Unusually Consistent Returns: Market trends can identify whether a digital asset profits or loses from an investment. If an investment regularly provides profits, regardless of what is happening in the market, is another common sign of Ponzi schemes.
Is Unregistered and/or Unlicensed: Legitimate stockbrokers and cryptocurrency companies are required by law to register with regional or federal authorities like the SEC in the United States. This enables individuals to get information about companies that they are going to invest in and helps them make informed decisions about whether or not to invest. Cryptocurrencies and brokers involved in Ponzi schemes would not be registered since they have something to hide.
Complex Investment Strategies: Msot Ponzi scheme will be hesitant to share the details of how their investments work.
Makes Receiving or Divesting Money Difficult: Not getting an investment payment when it is supposed to can be an important sign, as can having trouble when withdrawing money out of the investment account. The criminal may try to dissuade clients from divesting by convincing them that more money is on the way.
Are Ponzi Schemes Illegal?
Ponzi schemes are definitely an illegal activity due to two main reasons.
- Deceiving individuals into backing an organization that does not exist and offers no goods or services other than being the focal point of the fraudulent activity.
- The fraudsters will need to make their fake organization look legitimate in order to convince investors and not get caught. This activity involves forging and duplicating documents that a business has to submit to federal authority. It is an act of crime.
Also Read: What is Cryptocurrency Arbitrage?
Conclusion
A Ponzi scheme, no matter whether in traditional fiance of the digital currency landscape, is an illegal and fraudulent investment scam providing high returns with lesser risk elements to investors. It may begin by promoting a new digital currency that promises exponential growth in a few days. Early adopters will be incentivized with certain bonuses or huge returns. As more and more people purchase digital currency, its price artificially increases, further strengthening the illusion of a genuine investment opportunity. A most notable example of a cryptocurrency Ponzi scheme was BitConnect. When entering into the realm of cryptocurrencies, you should be more careful. Avoid scams like Ponzi schemes to ensure your safety and to avoid losing money.